The business of trading financial instruments involves three distinct disciplines.    1. Pre-trade: Provides the vital information allowing the user to develop a trading strategy. The information comes in the form of market news or market specific data. Such information is generally disseminated through a marketplace. The legal ownership of market data is not yet fully established, but for now, the existing exchanges “sell” market data directly or through data vendors to public. This segment of industry is by itself quite significant and is dominated by major news organizations.    2. Trade execution: Generally, the entities (or exchanges) develop and maintain standard products which can be traded in terms of financial instruments. These structured products are listed and traded according to certain rules established by exchanges. In recent years trading of a large number of unstructured contracts executed between buyer and seller and assisted by dealer, are becoming more dominant.    3. Post trade: The closing of the loop (trade cycle) requires the clearing of the transaction and settling the account. This implies coordination of payments among the so called “counter parties”. The clearing phase must be accompanied with respective trade settlement. Settlement is defined as legal transfer of title of financial instrument. It means transmitting, reconciling and confirming payment for security or physical and transfer instructions as prescribed by the clearing organization. The final positions for settlement are established on a net basis. In the security industry a Central Securities Depository (CSD) normally carries out such settlement.
The main functions of clearing address the specific and well established requirements. They are:                Assumption of obligations as a (central) counter party between buyer and seller of securities. This results in taking position (counter party at a time) by the organization and therefore protecting the party from financial risk.        Netting as referred to cash offset (of buying and selling) amount that would be “settled” as total amount paid or received.        Instruction to Settlement (entity) to execute payment transaction such as payment.        
Any discrepancy in settlement is referred to the clearing organization as the trade guarantor.
The heart of financial clearing and settlement is payments. The business of “payments” is the domain of banking industry. Within that industry few options are available when the issue of electronic commerce payment is addressed. The options are even less if demand deposit is to be used as means of payment. One reason for this inadequacy may be that the present clearing and settlement infrastructure are not suitable for consumers and businesses. This lack of adaptability stems from the requirement of continuous availability of market liquidity. The requirement stems from the heavy reliance on credit worthiness of the counter parties. For typical trading houses, that physically buy and sell products, any bi-lateral contract bears the risk of default by either party.
The issue of the time elapsed between the clearing and settlement is central to the extent that minimizing the risk requires a real time or near real time (same day) clearing and settlement. This is in sharp contrast to present period of several days now prevalent in the industry.
The Securities Industry Association (SIA) in its recent white paper states that immediate and final payment system at affordable price for businesses do not currently exist. Transition from “one to several days” interval for clearing and settlement to real time or near real time would require the banks, for example, to modify their internal accounting systems as well as their interfaces with clearing and settlement systems.
With the above in mind, most exchanges own and manage (some time jointly) their clearing organizations. They clear trades through clearing members, who in turn act as second tier clearing for their customers. By adopting the hierarchical approach, the exchanges manage their financial risk by distributing their risk exposure among the second tier clearing entities (brokerage firms) in all financial transactions.
Still, the lack of information among the clearinghouses at a given time results in potentially dangerous risk. If top 25 brokerage firms extend maximum credit to their customer and a customer walks away from the obligation there is no “global clearing” that collects that information to send a warning signal. In other words, the presumed risk management is only as effective as the information one gets.
Recently a series of articles have appeared in trade publications justifying the need for an open clearing architecture. The most important issue raised refers to the clearing cost. Clearing is needlessly expensive. Existing fees range from $0.5 to $0.85 (and sometime $1.00 or more with surcharges). The real cost lies in duplication of capital. A member of more than one exchange must make a security or guaranty fund deposit with each of those clearinghouses (or buy stock in that clearinghouse). The four largest clearinghouses: BTCC, CME, NYMEX and NYCC have combined deposit or stock purchase requirements of nearly one billion US Dollars. The deposit amounts range from $100,000 to $2 million at each of the clearinghouses. This is in addition to the performance bond which is really used to guarantee the transaction. As much as $30 billion of performance bond may be held up in an exchange whose products are being cleared.
While some steps have been taken to remedy this problem (notably netting of original margin payments and cross-margin positions for specific products the obvious solution is one combined clearinghouse which for various reasons has proved impractical (except Options Clearinghouse Corporation (OCC) which was originally designed for that purpose, namely standardized securities options).
Another solution known as direct clearing or “one account settlement” requires the clearinghouses to work together towards that end. This is similar to arrangements made among regional exchanges (Philadelphia, Chicago, . . . and NYSE linked through a Regional Interface Organization or RIO program). A version of this is used by CME and SGX known as Mutual Offset System (MOS), whereby one exchange clearinghouse becomes another one's clearing member. This is the same arrangements between OCC and European Options Clearing.
To allow a clearing participant (member) clear a transaction with respect to different Clearing Counter Parties (CCP) a bilateral MOS based on a unique reciprocal “clearing member status” between two trading platforms takes place. Such “uniqueness” translates to virtual clearing as back-end operation. The virtual clearing is simply a “mirror image”, or equal and opposite trade. MOS, when expanded multi-laterally, is the basis of Open Clearing. In a typical MOS, matched trades could be then “transferred” to clearing participants at any CCP in the system. The problem with this approach in that for n number of members n(n−1) connections are needed; a prohibitive cost.